Accounting and Financial Management

CAPRI LIMITED: PERFORMANCE EVALUATION AND PLANNING

For many years Capri Limited has delivered on its quality products promise to consumers, ensuring continued access to an ever-growing range of established and well-loved brands. Through a spirit of innovation, the company continues to deliver new and exciting products in response to the evolving needs of its customers. Despite its success the management has noted areas for improvement. This is evident in the following financial statements for the past two years:

CAPRI LIMITED
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2021
R
Cash flows from operating activities	756 000
Profit before interest and tax/Operating profit	900 000
Adjustments to convert to cash from operations	?
Add: Depreciation	252 000
?	?
?	?
Profit before working capital changes	?
Working capital changes	194 400
Decrease in inventory	288 000
Increase in receivables	(396 000)
Increase in payables	302 400
Cash generated from operations	1 346 400
Interest income	72 000
Dividends paid	?
Company tax paid	(388 800)
Cash flows from investing activities	(1 368 000)
Non-current assets purchased	(1 476 000)
Proceeds from sale of vehicles (sold at a profit of R150 000)	540 000
Increase in long-term investments	(612 000)
Disposal of long-term investments (disposed at a loss of R150 000)	180 000
Cash flows from financing activities	720 000
Proceeds from issue of ordinary shares	720 000
Net increase/decrease in cash and cash equivalents	?
Cash and cash equivalents at beginning of year	792 000
Cash and cash equivalents at end of year	?

CAPRI LIMITED
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2022
R
ASSETS
Non-current assets	5 040 000
Property, plant and equipment (cost)	4 980 000
Accumulated depreciation	(1 260 000)
Investments	1 320 000
Current assets	6 120 000
Inventory	2 100 000
Accounts receivable	2 460 000
Bank	1 560 000
Total assets 11 160 000
EQUITY AND LIABILITIES
Equity	7 500 000
Ordinary Share Capital	5 118 000
Retained Income	2 382 000
Non-current liabilities	2 700 000
Loan	2 700 000
Current liabilities	960 000
Accounts payable	576 000
Dividends payable	384 000
Total equity and liabilities 11 160 000

CAPRI LIMITED
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2022
R
Sales	8 400 000
Cost of sales	(5 304 000)
Gross profit	3 096 000
Operating expenses	(1 596 000)
Operating profit	1 500 000
Interest expense	(324 000)
Interest income	120 000
Profit before tax	1 296 000
Company tax	(390 000)
Profit after tax	906 000

NB: The values in brackets () means to be subtracted.

In addition to the above, the following information is available:

Interim dividends paid in 2022 amounted to R456 000. 511 800 shares were in issue during 2022. The market price per share was R17.25 on 31 December 2022.

During 2022 the management of Capri Limited considered the acquisition a new machine for purchase and installation during the second quarter of 2024 with a desired rate of return of 15%. The machine will cost R6 000 000 excluding import duties of R250 000 and will have a useful life of five years. The machine is expected to increase cash inflows by R2 000 000 per year, but cash expenses will increase by R300 000 per year. Depreciation is calculated using the straight-line method. At the end of December 2022 the company was approached by a group of previously disadvantaged women who had opened a service station on 01 July 2022 , selling only diesel. They needed assistance in improving the financial performance of the service station. Diesel was sold at R16 per litre and the variable costs totalled R14 per litre. The fixed costs were R135 000 per month. After six months of opening, the sales achieved was 540 000 litres and the sales were almost the same each month. To improve the performance, the Capri Limited considered the following proposals:

Proposal 1

Customers will be allowed to purchase diesel on credit. It is estimated that 60% of the average monthly sales (in litres) will be to customers who would take advantage of this opportunity. Sales to these customers should increase by 25% as they are expected to buy exclusively from this service station. Sales volumes to customers who do not take advantage of the credit policy are expected to remain unchanged. Additional costs arising from this proposal are expected to be:

Bad debts of 1% of the sales value in respect of customers who use the credit facility.

Fixed administrative costs of R7 500 per month.

Proposal 2

An operating profit of R25 000 per month would be the target. To achieve this the following changes are suggested:

The selling price is reduced by R0.30 per litre.

A sales commission of R1.50 per 10 litres sold will be granted to the diesel attendants.

R5 075 per month will be spent on advertising.

Proposal 3

The possibility of only operating from 06:00 to 22:00 is being considered. This earlier closing time is expected to result in a loss of sales on average of 12 500 litres per month. It is hoped that the saving in fixed costs resulting from the reduction in operating hours will enable the entrepreneur to achieve an average monthly operating profit of R30 000.

QUESTIONS

Refer to the proposed acquisition of a new machine for purchase and installation during the second quarter of 2024 and answer the following questions:

3.1) Calculate the Payback Period

3.2) Calculate the Accounting Rate of Return on initial investment

3.3) Calculate the Internal Rate of Return (expressed to two decimal places). Your answer must include two net present value calculations (using consecutive rates/percentages) and interpolation.

3.4) Calculate the Net Present Value if the machine is expected to have a scrap value of R300 000.

3.5) Suppose Capri Ltd funds the purchase of the new machine through the issue of 12% preference shares that are expected to sell for R10 each. If the floatation costs are estimated at R1 per share, calculate the cost of the preference shares (expressed to two decimal places).

3.6) Suppose Capri Ltd funds the purchase of the new machine through the issue of ordinary shares. Assume that the present value of an ordinary share of Capri Ltd is R17.25, the next projected dividend is R1.80 per share and the expected growth rate in dividends is 15% p.a. Use the Gordon Growth Model to estimate the cost of the ordinary shares (expressed to two decimal places).